In re 1300 Desert Willow Road, LLC

The bottom line

In a recent decision, Judge Phillip Bentley resolved an open question for the Southern District of New York that has divided other districts: Does Section 506(b)’s requirement that an oversecured creditor’s fees and charges be reasonable apply to prepetition amounts, postpetition amounts or both? Bentley ultimately found that Section 506(b)’s reasonableness requirement only applies to postpetition charges and that prepetition amounts are governed by state law. 

Bentley was a partner in HSF Kramer’s bankruptcy and restructuring department prior to his appointment as a United States Bankruptcy Court judge for the Southern District of New York in 2022.

Introduction

Section 506(b) of the Bankruptcy Code allows an oversecured creditor to recover “interest on such claim, and any reasonable fees, costs, or charges provided for under the agreement or State statute under which such claim arose.” 11 U.S.C. § 506(b). It is undisputed that this provision allows an oversecured creditor to recover postpetition interest, plus any reasonable postpetition fees or other charges, to the extent that the value of the creditor’s collateral exceeds those amounts. However, courts are divided on whether this provision imposes a separate reasonableness limitation on a creditor’s prepetition charges or if that limitation only applies to postpetition charges.

Bentley’s July 21 bench ruling in In re 1300 Desert Willow Road, LLC is the first decision out of the Southern District of New York to thoroughly address the issue. He held that Section 506(b), read together with Section 502(b), is ambiguous and several considerations compel a narrow construction, limiting Section 506(b)’s reasonableness standard to postpetition fees and charges.

Background

1300 Desert Willow Road, LLC (the Debtor) was a single-asset real estate entity that owned a light industrial manufacturing facility in Los Lunas, New Mexico. In re 1300 Desert Willow Rd., LLC, No. 25-11375 (PB), 2026 WL 2088511, at 1 (Bankr. S.D.N.Y. July 21, 2026) (Opinion). In April 2022, the Debtor took out a loan from Romspen, a real estate investment firm, for $20 million. Id. at 1. Later that year, the Debtor defaulted on the loan after several tenants vacated the property. Id. at 1. The Debtor entered into a series of forbearance agreements with Romspen that forestalled enforcement for a little over two years, id. at 1, and filed for Chapter 11 after the last agreement lapsed. Id. at 1. After the Debtor proposed a plan that the court ruled was not likely to be confirmed, the court instead approved a liquidating plan proposed by Romspen that called for a sale of the Debtor’s assets. Id. at 2.

Romspen was the Debtor’s only secured creditor. Id. at 2. In addition to the $20 million in principal, Romspen asserted approximately $6 million in interest and other charges. Id. at 2. The Debtor objected to a substantial portion of those charges. Id. at 1.

Treatment of oversecured claims under sections 506(b) and 502(b)

Section 502(b) of the Bankruptcy Code fixes a claim “as of the date of the filing of the petition,” so postpetition interest and other postpetition charges are generally not allowed. 11 U.S.C. § 502(b). Absent a Bankruptcy Code provision to the contrary, claims — assuming that they are proven — can be allowed unless they are not permitted under applicable nonbankruptcy law. Id. at 2; 11 U.S.C. § 502(b)(1) (a court shall allow a claim “except to the extent that – (1) such claim is unenforceable against the debtor and property of the debtor, under any agreement or applicable law”).

Section 506(b) is a limited exception to that rule. It permits an oversecured creditor to recover postpetition interest and “any reasonable fees, costs, or charges provided for under the agreement or State statute under which such claim arose.” Opinion at 3 (quoting 11 U.S.C. § 506(b)) (emphasis added). What is not settled is whether the “reasonable” limitation also applies to a creditor’s prepetition charges. The Fifth and Eleventh circuits have held that it does, reasoning that the text draws no line between fees that vest before and after the petition date. Id. at 3. A number of lower courts outside those circuits have held that it does not. Id. at 3. The Southern District of New York had not squarely addressed the issue. Id. at 3.

Bentley held that a narrow interpretation of Section 506(b)’s reasonableness standard, applying it to only postpetition amounts, harmonized that provision with Section 502(b). Id. at 4.

In doing so, Bentley first found that the statute is ambiguous. Id. at 3. On its face, Section 506(b) applies to all fees, costs and charges, regardless of whether they accrued pre- or postpetition. Id. at 3. However, imposing a reasonableness limitation on a creditor’s prepetition as well as postpetition charges would directly contradict Section 502(b), which unambiguously permits prepetition charges to the full extent allowed by nonbankruptcy law. Id. at 3. Unlike Section 502(b), which is unambiguous, Section 506(b) can be read broadly or narrowly, as either is applicable to all fees, regardless of when they arose, or only to postpetition fees. Id. at 4. Bentley preferred the narrower interpretation as consistent with the plain meaning of Section 502(b) and harmonizing the two provisions. Id. at 4.

While acknowledging that there are legitimate policy considerations for limiting the amount of fees paid to oversecured creditors, Bentley found that applying a reasonableness limitation for prepetition fees to only oversecured, and not undersecured, creditors would be absurd. Id. at 4. Rather, he held that Congress clearly did not intend to impose a reasonableness requirement on the prepetition fees of any secured creditor. Id. at 4. As Section 502(b) allows prepetition fees to the full extent permitted by state law, such fees are governed under state law and not limited by the Bankruptcy Code. Id. at 4.

Romspen’s prepetition late fees and forbearance fees

Applying New York contract law to the prepetition charges, Bentley disallowed Romspen’s prepetition late fees as duplicative of postpetition default interest and therefore constituting an impermissible penalty. Id. at 7. The court reasoned that under New York law, liquidated damages provisions that act as impermissible penalties are unenforceable. Id. at 7 (citing Truck Rent-A-Ctr., Inc. v. Puritan Farms 2nd, Inc., 41 N.Y.2d 420 (N.Y. 1977)). New York courts have applied a similar standard in the context of late fees. Id. at 7 (citing Beltway 7 Props., Ltd. v. Blackrock Realty Advisers, Inc., 167 A.D.3d 100, 106-7 (1st Dep’t 2018)). Bentley found that the stated purposes under the note of both the late fees and default interest were nearly identical, as both were intended to compensate Romspen for the additional administrative expense of dealing with the defaulted loan and the loss of the use of funds that the Debtor failed to pay. Id. at 7. The court therefore disallowed the prepetition late fees because they were duplicative of the note’s default interest and thus constituted an unenforceable penalty under New York law. Id. at 7.

Bentley took a different view of Romspen’s prepetition forbearance fees. He found that those fees were likely not impermissible penalties because they served a different purpose than liquidated damages. Id. at 9.

Whereas liquidated damages are an estimate of the injury that would result from a breach, forbearance fees compensate a lender for the risk that the value of its collateral will decline while it refrains from enforcing the contract. Id. at 9. And even if Section 506(b)’s reasonableness standard — which is less stringent than New York’s rule on unenforceable penalties — applied, the Debtor offered no evidence to show that the forbearance fees were unreasonable. Id. at 9. Because it could point to no other basis for disallowing Romspen’s prepetition forbearance fees, the court allowed that claim in the full amount. Id. at 9.

Romspen’s postpetition default interest and late fees

Bentley applied Section 506(b)’s reasonableness standard to Romspen’s postpetition charges and allowed Romspen’s postpetition interest at the default contractual rate. Id. at 11. An oversecured creditor enjoys a rebuttable presumption that interest should be enforced according to the default contract rate. Id. at 10 (citing In re 33 Mako LLC, 678 B.R. 274 (Bankr. S.D.N.Y. 2026)). The presumption is nearly irrebuttable when the debtor is solvent. Id. at 10. If the debtor is insolvent, the court may refuse to enforce the default interest rate if the debtor shows that at least one of four specific equitable considerations compels that outcome: (i) whether the contractual default rate is a penalty, (ii) whether there has been misconduct by the secured creditor, (iii) whether awarding postpetition interest at the contractual default rate would harm the creditors, and (iv) whether allowing such interest would have an adverse effect on the debtor’s fresh start. Id. at 10. 

The only factor the Debtor argued applied was that enforcing the default contract rate in its case would adversely impact its fresh start. Id. at 10. The court found that the fresh start factor was entitled to little or no weight. Id. at 10. Strictly speaking, the fresh start principle only applies to individual debtors, but courts have applied it to corporate debtors with employees and ongoing commercial operations. Id. at 10 (citing In re 53 Stanhope LLC, 625 B.R. 573 (Bankr. S.D.N.Y. 2021)). The Debtor, however, was a single-asset real estate entity with no employees beyond its principal. Id. at 10. There was nothing in the record to indicate that any jobs would be lost or that the Debtor’s tenants would be adversely affected if the property were to change hands. Id. at 10. The court therefore found that Romspen’s claim for postpetition interest was allowable at the default contract rate. Id. at 11.

Finally, the court disallowed Romspen’s claim for postpetition late fees. Id. at 11. Applying Section 506(b)’s reasonableness standard, Bentley noted that courts in the Southern District of New York have adopted an across-the-board rule that late fees duplicate default interest and therefore are per se unreasonable if the lender is being paid default interest. Id. at 11 (citing In re 785 Partners LLC, 470 B.R. 126, 137 (Bankr. S.D.N.Y. 2012)).

Why this case matters

Bentley’s decision resolves an important open question for bankruptcy practitioners and their clients in the Southern District of New York: Section 506(b)’s reasonableness requirement applies exclusively to a secured creditor’s postpetition fees, interest and other charges, while prepetition amounts remain governed by applicable state law. Thus, to the extent that an oversecured creditor is entitled to prepetition interest and fees, including liquidated damages, those amounts will be allowed if otherwise permitted under state law.